Twenty five years ago when Aditya Puri and Paresh Sukthankar sat with a band of bankers to tell potential investors in the initial public offering of HDFC Bank what they intended to do in their first three years, few knew what was possible. But regulations demanded they provide a business plan if they wanted capital from public markets.

After weeks of deliberations, they concluded the safest bet would be to say HDFC Bank would have 300 branches in three years. Come 2019, it has 5,130 branches and plans to open 700 branches in a year. That’s the gap between how one visualises the future and what it actually turns out to be, if things go right.

For HDFC Bank, which raised Rs50 crore in an IPO in May 1995 at Rs 10 a share with a market capitalisation of Rs 5.98 lakh crore, and 8 others that started the journey in a fledgling free market for financial services, it was like heading into unchartered waters. It was a voyage that could end up like it did for Christopher Columbus or Ferdinand Magellan.

Indian banking has its share of Columbuses and Magellans. A quarter of a century later, what is left is less than half of the banks that started from the grid. Accidents along the way killed some and other less efficient managed to marry themselves off to a financially sound partner.

As the nation gambled with the idea of private sector banks a quarter of a century after nationalising banks in the name of socialism, there were doubts, hopes and fear. Almost all of them came true. Some destroyed value, others created – for the nation, shareholders, depositors and customers.

“Largely they have turned out to be successful,” says C Rangarajan, the architect of private bank licences as the Governor of the Reserve Bank of India. “There have been one or two failures. But that will happen. But the whole thing is that private sector banks have established a position and their share in the total market is now significant, which was negligible in 1992.”

GROWING THE PIEThe Indian banking industry was Rs 2 lakh crore in 1995 with the nationalised banks being the sole financial services providers with a minuscule contribution from old private sector banks such as Karnataka Bank or Tamilnad Mercantile Bank. Of course, the size of the economy was relatively small too at Rs 1,015 lakh crore.

Bankers in the government-owned banks hardly had an elbow room to do any banking with almost everything dictated by the regulator. The industry was more like a piggybank for the government and the industrialists it favoured. Entrepreneurs with connections could get their way and individuals just put in their deposits without much scope to borrow from.

Historical reasons led to many new lenders such as HDFC Bank starting as wholesale banks. But over time, they realised there is an untapped potential in retail lending and CEOs like KV Kamath of ICICI Bank revolutionised retail lending for cars and personal loans.

“Retail had to be a big thing because Indians were underserved,” says Janmejay Sihha, chairman, Boston Consulting Group, a consultant. “We need to give credit to people like Aditya Puri, KV Kamath and PJ Nayak. Initially, they went after foreign banks and made their presence felt in forex, trade finance, mass affluent and structured products. And then they went to take on the public sector banks.”

Lending to individuals was non-existent. Now they account for 27% of total banking sector loans. Home mortgages account for 50.5% of ICICI Bank’s retail portfolio, and for SBI retail portion is 34% of total loans.

Other than growing retail business, the advent of private banks led to the entry of technology into banks. Contrary to bankers breaking computers in early 90s in protest against replacing the bulky black ledgers with desktop computers, they adopted Core Banking Solutions which ended almost 15 days wait to get credit for outstation cheques.

“They also encouraged existing players to introduce new technologies and also encouraged rest of the banking sector, including foreign banks to improve,” says Paresh Sukthankar, former deputy managing director at HDFC Bank. “The turnaround time that used to take days, be it sanctioning loans, settlements or cash management, has now come down to minutes. A loan can be now sanctioned in five minutes.”

THE GENESISAlmost every reform is born out of a crisis. So is the case with Indian economic reforms. The Balance of Payments crisis in 1991 forced the government to begin dismantling the licence permit raj. As Manmohan Singh began setting up framework for fiscal reforms under Prime Minister Narasimha Rao’s direction, Rangarajan as Governor began erecting a new monetary edifice.

Although RBI had the mandate to issue new banking licences, it did not until 1994 when the dust over the financial crisis settled. It was also the time when the markets were rocked by frauds in the nonbanking finance companies segment with CRB Financial being the prime example. It was a providential escape for the RBI which was about to give a banking licence to CRB as well.

The central bank had to guard against one particular issue — big industrialists — a smokescreen created to nationalise banks in the first place by Indira Gandhi in 1969. They were barred from bidding.

“If we left it open, thousands of applications would come and one question that arose was whether business houses should be given the licence or not,” says Rangarajan. “So we took the view that we cannot give licences to the private corporates. We had a sort of priority in which we did give to financial institutions which were already there, where we saw ICICI, IDBI and HDFC got the licences.”

Institutions such as IDBI, ICICI, HDFC and UTI were given licences. Others who managed were Centurion Bank, Bank of Punjab, Times Bank, Global Trust Bank and IndusInd Bank of the Hindujas. Barring IndusInd, all the others are merged into another bank.

Global Trust Bank, run by a former banker Ramesh Gelli, was the first one to blow up among the new-age banks in the midst of a scandal. It raised questions about RBI’s judgement. But the central bank was quick enough to identify problems and merge it with Oriental Bank of Commerce in 2004.

“Soon after I joined as Governor in September 2003, I had to take a view on cleaning up GTB,” YV Reddy writes in his memoirs, Advice & Dissent. “GTB continued to be on the list of problem banks. We sounded leading private sector banks if they could take over GTB. Surprisingly, they did not evince interest. We decided to act before it is too late.”

Whether it was Global Trust or Centurion, the managements were in a hurry to build up market valuations. Greed got the better off virtue.

“What went wrong with the others that went bust — one tends to go on to the fringes of integrity,” says Sukthankar. “It is not black and white. Some of the easy mistakes that you made are not visible at the top level. You can generate positive returns only if you protect your integrity. Success of HDFC Bank is not because what we did, but also because what we did not do.”

Centurion Bank of Punjab and Times Bank merged with HDFC Bank. IDBI Bank, which merged with parent Industrial Development Bank of India, is a standing example of how not to run an institution.

“Private banks gave you a chance to become rich,” says Sinha of BCG. “But boards did not do all that well. Governance was an issue. The quality of the board of directors of these banks has been varied. They have not managed to keep a check on CEOs, succession planning and not robustly manage risks.”

FEAR AND HOPESince Rangarajan’s time of restricted licensing and completely barring industrialists, the RBI has come a long way. Now licences are on tap. That Hindujas-run IndusInd, after getting licence as a group of non-resident individuals to avoid getting grouped under ‘industrialists’ opens up many possibilities. But at the same time worries about ownership have begun to surface with foreigners owning the bulk of Indian private banks.

“Foreign shareholding in the largest private sector banks is well over 70%,” Reddy said in a recent lecture. “Our banking system is predominantly owned by government, followed by foreigners and least by Indians. I repeat least by Indians. Indian-incorporated but foreign-owned banks are no substitute for Indian-owned banks. With the widespread acceptance of proxy advisers by foreign institutional advisers, they operate in tandem. Hence, the diversified ownership as a buffer is a myth.”

HDFC Bank is 38.64% owned by foreign investors. As far as ICICI Bank is concerned, 43.2% is owned by global portfolio investors. In IndusInd Bank, it is 51.47% and 40.52% in Kotak Mahindra Bank. They constitute 81% of the total Rs 15.4 lakh crore market capitalisation of all new private sector bank.

This exposes India to the whims and fancies of political leaders elsewhere. President Donald Trump has been unconventional when it comes to global trade and investments. He has torn many treaties and agreements putting businesses at risk.

“More than 40% of the new private banks in India are owned by US investors,” says Sinha of BCG. “So if the US President announces sanctions for some reason, then we could be in trouble. Imagine if there were sanctions against India and in case of a capital pull-out, from where could we raise so much capital? We have to be deeply careful on our exposure.”

At the same time, the regulator also has to revisit its guidelines on licences. Of late, the shadow banking system like the nonbanking finance companies have become critical. In fact, it is their weakness that has shaken the system in the past year.

Given that nearly half the NBFCs that account for more than a quarter of the segment is owned by industrial groups, they may have to be considered for a bank licence with checks and balances.

But the central bank may be more careful than ever with a lender like Yes Bank causing troubles in the system and many NBFCs getting into trouble because of mismanagement.

So what is ideal?“My view is that when we start giving licences now, you should look at what India needs not now, but two decades from now,” says Rangarajan. Given the current gloom and none seeking bank licences on tap, what’s possible for a new bank?

“Now we say our story has just begun,” says Puri of HDFC Bank. “You see us in five years from today…you will not recognise the bank. So we are again a start-up now.”

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